In the beginning, you may not have given a lot of thought to your business’s legal structure, especially if you’re going at it alone. This means you’re operating as a sole proprietor, but at some point, it may make sense to incorporate your business.
[Read more: When—And Why—to Consider Changing Your Business Entity]
What is a sole proprietorship?
If you’re just getting started as a small business and haven’t decided on a business structure yet, then you’re automatically operating as a sole proprietor. There are over 23 million sole proprietors in the United States, making it the most popular business structure by far.
There is no paperwork you have to fill out or fees you need to pay as a sole proprietor. Since you’re the only owner, there’s also no bureaucracy to contend with or board meetings to conduct.
However, there’s also no liability protection for sole proprietors. There’s no legal separation between you and the business, so you’re responsible for any lawsuits, liabilities or debts the business incurs. And it’s going to be much harder to seek out small business financing as a sole proprietor.
So while you may choose sole proprietorship in the beginning, you may reach a point where it makes sense to incorporate your business. This means you’ll set up a legal business entity as either a limited liability company (LLC) or a corporation.
[Read more: How to Choose the Right Business Entity: Sole Proprietorship]
How to incorporate a sole proprietorship
The process of incorporating your sole proprietorship will vary depending on where you live and the type of business you run. But here are five general steps you can take to get started:
- Choose a business entity: You’ll start by deciding whether you want to set up an LLC or a corporation. An LLC will offer liability protection and is simpler to set up and manage than a corporation. A corporation can give you the credibility needed to secure small business funding. It’s a good idea to consult with an attorney about which is the right choice for you
- Name your business: Once you’ve chosen a business model, you need to name your small business. Once you’ve selected a name you like, be sure to check the trademark database to ensure the name isn’t already trademarked.
- Apply for an EIN: Even if you don’t plan on hiring any employees, you need to apply for an Employer Identification Number (EIN). This federal tax identification number is used to verify your business’s identity. Applying for your EIN is free, and you’ll receive the paperwork immediately. Make sure you print out the form given to you by the IRS after your application is approved.
One of the biggest benefits of incorporation is that it protects your personal assets.
- Open a business bank account: Next, you need to set up a business checking account for your small business. A business account will help you keep your personal and business assets separate. Before you can open your business checking account, you’ll need your personal identification and EIN on hand.
- File your Articles of Incorporation: Finally, you’ll need to file the Articles of Incorporation with the state. The process can vary depending on where you live, so be sure to check on your local requirements. Depending on the type of business you run, you may be required to obtain certain business licenses and permits.
[Read more: Getting Ready to Launch? How to Choose the Right Business Structure]
How to know when it’s time to incorporate your business
One of the biggest benefits of incorporation is that it protects your personal assets. For example, if you’re a sole proprietor and your business is sued, your personal assets will be on the line. However, if you’re running an LLC or a corporation, you’ll benefit from the added liability protection. Since there is a legal separation between you and your business, you won’t be responsible for any debts or liabilities the business incurs.
If you think you may want to apply for small business financing in the future, incorporating your business makes sense. And it’s a good idea to make the switch before you need to.
It can be tempting to wait, but if you do, you may find yourself unable to access funding when you really need it. This can significantly limit your business’s growth and opportunities.
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